How Human Behavior Drives Investment Activity

Understanding human behavior is crucial for investors, according to Alliance Capital Management CEO Lewis A. Sanders, who talked about behavioral finance and its role in pricing anomalies and forecasting bias during a presentation last month at Wharton.

"Capital markets themselves are derivative of the biases and preferences people bring to decision-making," Sanders told his audience, adding that insights into behavioral finance hold true across fixed-income, debt or equity markets and national boundaries.

"People are people wherever you find them."

Sanders, who spoke as part of part of Wharton's Musser-Shoemaker Lecture series, has spent a career in investment research, starting as an analyst at Sanford C. Bernstein & Co., Inc. in 1968. He rose to become chairman of the firm, which merged in 2000 with Alliance, one of the world's largest investment managers. In 2003, he was named chief executive of Alliance, which has $480 billion under managementand 6.9 million mutual fund accounts.

At the moment, he said, markets are relatively calm and not generating
big price anomalies. "The world is not in a very provocative state, but something will come along. Maybe it will be oil. Maybe it will be currency. Who knows, maybe it will be broadband. I can think of any number of developments." He disputed conventional wisdom which says that superior information gives investors a leg up in making better decisions. "Everybody has the information. But are people reacting to it rationally?"

Asset prices are driven by three main human preferences, according to Sanders. The first is what he called "the overwhelming affection for things that are, or appear to be, certain." For example, he said, most household wealth is in assets that have low, or no, volatility, at the expense of earning higher returns. Another trait that plays on markets is people's tendency to ignore probability if a large payoff is at stake. "It's going for the gold. Probability is essentially irrelevant," said Sanders, who likens the behavior to lottery ticket sales that increase as the jackpot rises, even though the likelihood
of winning diminishes. "In the capital markets this is a profound phenomenon because it fuels most bubbles."

Another strong trait that plays out in markets is loss aversion. "In people's minds, losses loom larger than gains," said Sanders. "People just don't like losing money. The only thing they dislike more are money managers who lose it for them." In effect, Sanders argued, sellers fearful of losing money will wind up undercutting the price of their assets. "The sellers are paying the buyers to rid themselves of the stress of ownership that they can no longer endure." These traits are reflected in investing styles, according to Sanders.

Value investors, he said, are willing to take on the stress, but in return they spend their lives "being depressed, afraid and subject to repeated threats to their self-esteem." Growth investors seek a declining risk premium and are willing to pay more for perceived certainty. Finally, there are speculators, whom Sanders described as being often cloaked as growth investors, operating on "skewness" or extremes in price swings.

Human behavior also influences forecasting, Sanders told his audience.

Much of the bias in market forecasts derives from "mental shortcuts. Typically, we're overconfident." Forecasters seek to find an anchor or reference point to build projections, but the anchor can be based in quicksand. Many forecasters focus too much on their own, recent
experiences, Sanders noted, adding that corporate managers, too, seek anchors and will cling to business plans they have recently formulated even if the plan is not working. "All of this leads to inadequate judgments in the face of change."

The "Inertia of Regret"
Investors create price anomalies when they are slow to change course due to what Sanders called the "inertia of regret. The regret associated with taking action is considerably greater than taking no action at all, which leads to inertia."

Forecast biases are influenced by what Sanders identified as the availability heuristic - or judgments based on information that is easy-to-grasp and readily available in the decision-making environment. He pointed to the hype surrounding the stock market peaks during the Nifty Fifty craze in the early 1970s, the real estate bubble in the early 1990s and the spike in Internet stocks in 2000.

"If you look at all the peaks, they are associated with very popular wide-spread ideas about what the future held. The winners and losers were divided along a simple boundary. In the Internet bubble it was the new economy versus the old economy. There was hopelessness around the old economy companies.

"Looking back [these bubbles] seem too obvious," conceded Sanders, "but when you are in them, the ability to extrapolate what's underway is very difficult."

Sanders pointed to research indicating that consensus growth-rate forecasts for companies will remain on the same track, either fast or slow, as a cautionary sign. "People are very married to extrapolating recent success," said Sanders, noting that in fact, very few companies remain on the same course and tend to revert to the mean. Moreover, forecasters often underestimate a poorly performing company's ability to turn itself around. "An interesting bias is the inability to
imagine that someone will conjure up a way out. You don't see one and management hasn't offered one. However, the probability is that with time and pressure they will, as all those mean reversions clearly imply."

This so-called "failure of initiative" generates some of the best investment moves. He pointed to problems at Citigroup and IBM in the early 1990s that turned out to be opportunities. He also noted the forecasting danger of "misplaced concreteness." What's going on here" is the forecaster has proposed an elegant model with many variables and it fits so well you start to think you really have discovered something. People fall in love with these models."

The problem, said Sanders, is that with more variables, data and complexity introduced to a model, the greater the chances it will implode. "The message in all of this is you have to understand that as forecasters you have limitations. Things are going to get blown around by the issues of the day. You have to wager with a certain sense of humility."

Asked what psychological traits make good analysts, Sanders said drive would come first. Communication skills are also essential, not only the ability to write and articulate a position, but also to listen. "You'd be surprised how many research analysts don't really listen.
They develop a point of view and when they do an interview with someone who has knowledge, they don't really pay attention. They're more interested in supporting a preconceived view."

Finally, Sanders said that while he looks for intelligence, brilliance can be a liability. "People who are brilliant spend their entire lives never being wrong. In a forecast setting they're vulnerable. A little bit of insecurity is a good thing."

Investment managers need to consider their fiduciary responsibility when building portfolios, Sanders concluded. He pointed out that it would have been responsible to acquire Citigroup in 1991 when the company appeared to be on the edge of failure. But a move like that is often difficult to justify to clients. The problem comes "when you can't explain why you bought all this garbage … It's difficult, without the depth of research to see through the anomalies, to explain
why you will ultimately win and why you are not gambling with the client's money."

Maximum wealth "isn't all there is to life," Sanders added. "In the value world in particular, you make the most money by feeling the most insecure. Do you really want to do that with your life? Is it worth it?"

Pearls of Wisdom

" Vision without action is merely a dream. Action without vision just passes the time. Vision with action can change the world."
- Joel Barker

" The fishermen know that the sea is dangerous and the storm terrible, but they have never found these dangers sufficient reason for remaining ashore."
- Vincent Van Gogh

" No one gets an iron-clad guarantee of success. Certainly, factors like
opportunity, luck and timing are important. But the backbone of success
is found in basic concepts like hard work, determination, good planning and perseverance." -
- Merlin Olsen

"Individual commitment to a group effort - that is what makes a team work."
- Vince Lombardi

"Your talent is God's gift to you. What you do with it is your gift back to God"
- Leo Busecaglia

"It is on our failures that we base a new and different and better success."
- Havelock Ellis

"People become quite remarkable when they start thinking they can do things. When they believe in themselves, they have the first secret of success."
- Norman Vincent Peale

"If your heart acquires strength, you will be able to remove blemishes from others without thinking evil of them."
- Mohandas K. Gandhi

"Always bear in mind that your own resolution to succeed is more important than any other one thing."
- Abraham Lincoln

"Small opportunities are often the beginning of great enterprises."
- Demosthene

"Many people have a wrong idea of what constitutes true happiness. It is not attained through self-gratification, but through fidelity to a worthy purpose."
- Helen Keller

"The greatest discovery of our generation is that human beings can alter their lives by altering their attitudes of mind. As you think, so shall you be."
- William James

THE 90/10 PRINCIPLE

Have you read this before? Discover the 90/10 Principle. It will change your life (at least the way you react to situations). What is this principle? 10% of life is made up of what happens to you. 90% of life is decided by how you react. What does this mean? We really have no control over 10% of what happens to us. We cannot stop the car from breakingdown. The plane will be late arriving, which throws our whole schedule off. A driver may cut us off in traffic. We have no control over this 10%. The other 90% is different. You determine the other 90%.

How? By your reaction. You cannot control a red light., but you can control your reaction. Don't let people fool you; YOU can control how you react.

Let's use an example. You are eating breakfast with your family. Your daughter knocks over a cup of coffee onto your business shirt. You haveno control over what just what happened. What happens when the next will be determined by how you react. You curse. You harshly scold your daughter for knocking the cup over. She breaks down in tears. After scolding her, you turn to your spouse and criticize her for placing the cup too close to the edge of the table. A short verbal battle follows. You storm upstairs and change your shirt. Back downstairs, you find your daughter has been too busy crying to finish breakfast and get ready for school. She misses the bus. Your spouse must leave immediately for work. You rush to the car and drive your daughter to school. Because you are late, you drive 40 miles an hour in a 30 mph speed limit. After a 15-minute delay and throwing $60 traffic fine away, you arrive at school. Your daughter runs into the building without saying goodbye. After arriving at the office 20 minutes late, you find you forgot your briefcase. Your day has started terrible. As it continues, it seems to get worse and worse. You look forward to coming home, When you arrive home, you find small wedge in your relationship with your spouse and daughter.

Why? Because of how you reacted in the morning. Why did you have a bad day?
A) Did the coffee cause it?
B) Did your daughter cause it?
C) Did the policeman cause it?
D) Did you cause it?

The answer is D. You had no control over what happened with the coffee. How you reacted in those 5 seconds is what caused your bad day. Here is what could have and should have happened. Coffee splashes over you. Your daughter is about to cry. You gently say, "It's ok honey, you just need,to be more careful next time". Grabbing a towel you rush upstairs. After grabbing a new shirt and your briefcase, you come back down in time tolook through the window and see your child getting on the bus. She turns and waves.You arrive 5 minutes early and cheerfully greet the staff. Your boss comments on how good the day you are having.
Notice the difference? Two different scenarios. Both started the same. Both ended different. Why? Because of how you REACTED. You really do not have any control over 10% of what happens. The other 90% was determined by your reaction.

Here are some ways to apply the 90/10 principle.

If someone says something negative about you, don't be a sponge. Let the attack roll off like water on glass. You don't have to let the negative comment affect you! React properly and it will not ruin your day. A wrong reaction could result in losing a friend, being fired, getting stressed out etc.

How do you react if someone cuts you off in traffic? Do you lose your temper? Pound on the steering wheel? A friend of mine had the steering wheel fall off) Do you curse? Does your blood pressure skyrocket? Do you try and bump them? WHO CARES if you arrive ten seconds later at work? Why let the cars ruin your drive? Remember the 90/10 principle, and do not worry about it.

You are told you lost your job. Why lose sleep and get irritated? It will work out. Use your worrying energy and time into finding another job.

The plane is late; it is going to mangle your schedule for the day. Why take out your frustration on the flight attendant? She has no control over what is going on. Use your time to study, get to know the other passenger. Why get stressed out? It will just make things worse. Now you know the 90-10 principle. Apply it and you will be amazed at the results. You will lose nothing if you try it.

The 90-10 principle is incredible. Very few know and apply this principle. The result? Millions of people are suffering from undeserved stress, trials, problems and heartache. There never seem to be a success in life. Bad days follow bad days. Terrible things seem to be constantly happening. There is constant stress, lack of joy, and broken relationships. Worry consumes time. Anger breaks friendships and life seems dreary and is not enjoyed to the fullest. Friends are lost. Life is a bore and often seems cruel. Does this describe you? If so, do not be discouraged .

You can be different! Understand and apply the 90/10 principle. It will change your life.

Courtesy : Stephen Covey

Thinking of quitting ??

A candidate for a news broadcasters post was rejected by officialssince his voice was not fit for a news broadcaster. He was also toldthat with his obnoxiously long name, he would never be famous.
He is Amitabh Bacchan, the famous Indian actor.

A small boy the fifth amongst seven siblings of a poor father, wasselling newspapers in a small village to earn his living. He was notexceptionally smart at school but was fascinated by religion androckets. The first rocket he built crashed. A missile that he builtcrashed multiple times and he was made a butt of ridicule. He is theperson to have scripted the Space Odyssey of India single handedly.

He is Dr. A P J Abdul Kalam, President of India.

In 1962, four nervous young musicians played their first recordaudition for the executives of the Decca recording Company. Theexecutives were not impressed. While turning down this group ofmusicians, one executive said, "We don't like their sound. Groups of guitars are on the way out."

The group was called The Beatles.

In 1944, Emmeline Snively, director of the Blue Book Modelling Agencytold modelling hopeful Norma Jean Baker, "You'd better learnsecretarial work or else get married."

She went on and became Marilyn Monroe.

In 1954, Jimmy Denny, manager of the Grand Ole Opry, Fired a singerafter one performance. He told him, "You ain't goin' nowhere....son.You ought to go back to drivin' a truck."

He went on to become Elvis Presley.

When Thomas Edison invented the light bulb, he tried over 2000experiments before he got it to work. A young reporter asked him how itfelt to fail so many times. He said, "I never failed once. I inventedthe light bulb. It just happened to be a 2000 step process."

When Alexander Graham Bell invented the telephone in 1876, it did notring off the hook with calls from potential backers. After making ademonstration call, President Rutherford Hayes said, "That's an amazinginvention, but who would ever want to see one of them?"

In the 1940s, another young inventor named Chester Carlson took his idea to 20 corporations, including some of the biggest in the country.They all turned him down. In 1947, after 7 long years of rejections, hefinally got a tiny company in Rochester, NY, the Haloid company, to purchase the rights to his invention an electrostatic paper copying process.

Haloid became Xerox Corporation.
A little girl the 20th of 22 children, was born prematurely and her survival was doubtful. When she was 4 years old, she contracted doublepneumonia and scarlet fever, which left her with a paralyzed left leg.At age 9, she removed the metal leg brace she had been dependent on andbegan to walk without it. By 13 she had developed a rhythmic walk, whichdoctors said was a miracle. That same year she decided to become arunner. She entered a race and came in last. For the next few yearsevery race she entered, she came in last. Everyone told her to quit,but she kept on running. One day she actually won a race. And thenanother. From then on she won every race she entered.

Eventually this little girl Wilma Rudolph, went on to win three Olympic gold medals.

A school teacher scolded a boy for not paying attention to hismathematics and for not being able to solve simple problems. She toldhim that you would not become anybody in life.

The boy was Albert Einstein.
The Moral of the above: Character cannot be developed in ease andquiet Only through experiences of trial and suffering can the soul bestrengthened, vision cleared, ambition inspired and success achieved.You gain strength, experience and confidence by every experience whereyou really stop to look fear in the face. You must do the thing youcannot do. And remember, the finest steel gets sent through the hottest furnace. In LIFE, remember that you pass this way only once! let's live life to the fullest and give it our extreme best.

"Failure is the pillar of success!" And if you know me well - you will vouch for it - every word.

Commonly Used Phrases..

Commonly Used Phrases at the Official communications and... What they really mean!(in the lighter vein..of course)

1) For your information, please. (FYI)
We don't know what to do with this, so please keep it.

2) Noted and returned.
We don't know what to do with this, so please keep it little while.

3) Review and comment.
Do the dirty work so that I can forward it.

4) Action please.
Get yourself involved for me. Don't worry, I'll claim the credit.

5) For your necessary action.
It's your headache now.

6) Copy to.
Here's a share of the headache.

7) For your approval, please.
Put your neck on the chopping board for me please.

8) Action is being taken.
Your correspondence is lost and we are still trying to locate it.

9) Your letter is receiving our attention.
We are still trying to figure out what you want.

10) Please discuss.
I don't know what this is, so please brief me.

11) For your immediate action.
Do it NOW! Or we'll all get into trouble.

12) Please reply soon.
Please be efficient. It makes me look inefficient.

13) We are investigating/processing your request with the relevant authorities.
They are causing the delay, not us.

14) Regards.
Thanks for reading all the above nonsense.